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More Pain at the Pump

The road to hell is paved with good intentions, says the old saw. It may soon be lined with higher-priced gas stations, too, thanks to Maryland’s General Assembly.

State lawmakers are considering legislation to ban motor fuel “zone pricing,” under which fuel wholesalers charge higher prices to some retail gas stations than to others. Understandably, retailers oppose the practice, and legislators worry that it’s unfair. But if lawmakers vote to prohibit zone pricing, consumers will end up paying higher gas prices, because low-price stations will end up charging more.

Wholesalers charge some retailers higher prices because those retailers charge higher prices to consumers. Like all businessmen, retailers facing limited competition - those at significant distances from lower-cost stations - set their prices as high as the market will bear to maximize their profits.

“Consumers, as a group, would pay more for gas, but some station owners would get to keep much of the excess profits.”

Wholesalers long ago discovered what retailers were doing, and started zone pricing so they could get a piece of the action. Surprisingly, zone pricing doesn’t raise gas prices for consumers, because retailers are already charging as much as the market allows. Instead, retailers are forced to share the excess profits with wholesalers. Understandably, retailers want Annapolis to outlaw zone pricing so they can keep all the excess profits.

Why shouldn’t Annapolis grant the retailers’ wish? If high-priced gas stations charge the same prices with or without zone pricing, shouldn’t the excess profits stay with local businesses instead of going to wholesalers? To answer those questions, consider what would happen if the legislation passed and wholesalers were required to set a statewide price.

Just as wholesalers now charge high prices to some stations, they also charge lower prices to others - specifically to stations in competitive areas with low profit margins. The wholesalers do this because if they charged more, their low-profit retailers would go out of business; the prices wouldn’t cover the station’s costs. So the wholesaler charges a lower price to the retailer in order to keep the station in business and maintain a modestly profitable outlet.

If wholesalers were made to set a single statewide price, they would set that price higher than their current lowest prices, because they’d make more money by going after high-priced stations’ excess profits, even at the expense of some of their low-profit outlets. It’s common sense: If wholesalers now charge higher prices to some retailers and lower prices to others, they’d set a uniform price somewhere in between.

Because their wholesale costs would go up, low-price stations would have to raise prices to comply with the law.

Maybe that’s fair: Consumers, as a group, would pay more for gas, but some station owners would get to keep much of the excess profits. But before consumers accede to higher gas prices, they should remember the previous benefits Maryland lawmakers have given gas retailers at their expense.

In 1974, station owners complained to Annapolis that big oil companies were opening their own stations and would push out some franchisees. Maryland became the first state to pass a “divorcement” law, requiring that all branded motor fuel be sold through franchisees. The law, in essence, is a “mandatory middleman” requirement that all gasoline undergoes a franchisee markup, while big oil companies are freed from having to compete with each other directly on consumer prices. The Federal Trade Commission calculates that the law raises Maryland’s gas prices by more than 2.5 cents per gallon.

In 2001, station owners again complained to Annapolis, this time about fuel discounters such as shoppers’ clubs and stores like Sheetz and Wawa. The station owners whined that the discounters’ prices were “unfair” and that Sheetz and Wawa would put Exxon and BP stations out of business. Again, the legislature came to retailers’ aid, setting weekly adjusted minimum prices for gas and requiring low-priced discounters to prove that their prices aren’t unfair. Economists calculate that the law costs consumers about 1.5 cents per gallon.

Now, Maryland may become the first state to ban zone pricing. Maybe it’s worthwhile to divert excess profits from wholesalers to retailers. But is that worth raising gas prices in the few places where competition is working for consumers?